Don't compare apples to oranges

Question: How are investors impacted by premium pricing of muni bonds?

Ann Ferentino: If you look at the Bloomberg Muni Bond Index and you compare it to the Bloomberg Corporate Bond Index, and you look at the average price of a bond in each of those indexes, you're going to see that the muni bond index is priced at a premium and the corporate bond index is at a discount. And so a lot of times, investors are concerned if they should consider that when making a decision between buying a muni or taxable bond. You cannot compare a bond based on price. Just because a bond is priced at a premium does not mean that it's better than a bond priced at a discount. You want to look at the bond's yield, the yield being that's the true return to an investor. So when you compare the yields on a bond, from one bond to another, a lot goes into that yield. There's lots to consider, the maturity of the bond, the coupon rate on the bond, the credit spread. But investors will often say, 'I don't want to buy a premium bond when I only get par back at maturity.' They're hesitant, right, to pay that extra price for the bond when they only get par back. And what they don't understand is that they are being compensated for paying that premium through a higher coupon rate. So the reason a bond is priced at a premium is because the coupon rate is higher than the yield on the bond. And a lot of times investors get confused on that difference between what is a coupon rate and what is the yield, and the coupon rate is a fixed rate, annual cash flow that that bond pays. The yield is the return that the investor is getting on the bond, and the yield does change, and it's an indication of the value of that bond. So investors should not be hesitant to buy premium bonds. In fact, premium bonds can have key advantages, especially in a rising rate environment. Because of the higher coupon, you're getting a higher cashflow, you're getting a higher distribution of your income, which you can then invest at higher rates. And also, that higher coupon is giving you protection from rising interest rates, making the price performance of your bond better in a rising rate environment and less volatile.